- Three reasons gold is at — or near — a bottom
- More timeless market wisdom, late-summer volatility be damned
- When government issues IOUs, Illinois Lottery edition
- Soviet-style policy to rescue the U.S. oil industry… parsing “smart regulation”… and more!
“Our estimate is that gold has now found a bottom and is poised to move steadily upward from current levels,” Jim Rickards wrote his premium subscribers this week.
It’s dangerous to call a bottom in any asset class. Doubly so when you approach markets the way Jim does — grappling with probabilities in a world where certainties are few and far between.
That said, “using our IMPACT system, which combines complex dynamic systems analysis with unique access to relevant information, we are able to draw some useful inferences about the future path of gold prices. We have identified three factors that well explain the gold price dynamics. ”
Strap in. Here we go…
“Real interest rates are one of the best predictors of the nominal dollar price of gold,” says Jim — identifying factor No. 1.
“When real interest rates are low (or negative), that gives gold a boost. When real interest rates are high, that puts downward pressure on gold.
“The reason for the correlation is easy to understand. Gold has no yield. Gold’s valuation has to compete with other asset classes such as stocks and bonds that do have yields. When yields on competing asset classes are higher, the gold price tends to suffer, and vice versa.”
Understand, we’re talking real interest rates — that is, after inflation. This morning, a 10-year Treasury note yields 2.17%. Subtract the official inflation rate of 0.2% and you get a real interest rate just below 2%.
That sounds low… but as Jim explained back in May, it’s been much, much lower. In 1980, when gold reached a generational high of $800, Treasuries yielded about 13%… but inflation was out of control at 15%. Real rates were minus 2%.
“Don’t be misled by low nominal interest rates,” Jim warns. “Focus on the real rates instead and you’ll have better insight into the future price of gold.”
“The second factor is dollar strength,” Jim tells us.“ A strong dollar signals a weak dollar price of gold, and a weak dollar signals a strong dollar price of gold.
“The best measure of dollar strength (other than gold itself) is the Price-Adjusted Broad Dollar Index maintained by the Federal Reserve Board.” It’s a more balanced measure than the commonly cited dollar index — which is dominated by the euro and includes no emerging-market currencies.
Let’s take a look…
The all-time low for this index came in July 2011 — two months before gold reached its all-time high. Today, the index sits at a six-year high while gold sits near a six-year low.
As with real interest rates, “the correlation is not perfect,” says Jim, “but it is surprisingly robust.”
“The third factor is central bank intervention,” Jim declares.“ Here the case is straightforward: a simple matter of supply and demand.”
Mining output has been constant in recent decades — about 2,000 tons per year. Meanwhile, Western central banks ceased dumping their gold five years ago… even as the Chinese and the Russians have been buying with both hands. Result: Central banks as a whole became net buyers of gold in 2009.
“With few official sellers and many official and nonofficial buyers, gold demand now exceeds gold supply from mines, putting pressure on scrap gold and other weak hands to fill the gap,” Jim says.
“All three factors — real rates, the strong dollar and official sales — are pointing toward a reversal of recent trends and momentum toward conditions that favor higher gold prices,” Jim figures.
“Central banks cannot tolerate high real interest rates, because they burden consumption and investment. The Federal Reserve cannot tolerate a strong dollar because it imports deflation (in the form of lower import prices) from around the world.
“Physical markets are skewed toward excess demand because China, Russia, Iran and other countries continue to demand gold to diversify reserves away from dollars while output is flat and official sales by the West have ceased.
“For those who are fully allocated in physical gold (I recommend about 10% of investible assets), there’s nothing more to do on that front. You can just sit tight and enjoy the ride.”
However… Jim’s proprietary IMPACT system has identified a high-probability trade that can juice gold’s potential. We’re talking tripling your money in the next six months.
It’s as sure a thing as you can find right now — when nearly every asset class is getting whipsawed. To take the current market volatility and use it to your advantage, check out this brand-new video message from Jim. It’ll take less than two minutes to watch.
Upon writing, the Dow is up 164 points, to 16,515 — still sitting below its record close on May 19.
The S&P too. It’s up 25 points, to 1,973. And gold is down by $8.08, to $1,124.50.
“Every market of every age is unique for many reasons. And yet the core principles of investing never change,” observes our investment director Chris Mayer.
In yesterday’s 5, Chris passed along some sage guidance from Charlie Munger, Warren Buffett’s longtime partner at Berkshire Hathaway. Said Munger at the nadir of the financial crisis in early 2009, “If you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder.”
One of Chris’ readers objects: “Notice that he said two or three times per century, not three times in 15 years! Our contemporary financial world is in a very peculiar place, with a central bank in every currency region intervening in markets in ways that would never have been tolerated a few decades ago.”
“Imagine yourself 20 years ago,” says Chris by way of reply.“ It’s 1995. And you look back over the past 30 years.
“You recall: the Vietnam War, wage and price controls, two oil shocks, the resignation of a president, the fall of the Soviet Union, a one-day drop in the Dow of 508 points — when that was a 23% move — and Treasury rates fluctuating 2.8-17.4%.
“And yet… the basic principles of sound investing still applied.”
As evidence, Chris submits Warren Buffett’s 1994 shareholder letter. “Imagine the cost to us, then,” Buffett wrote, “if we had let a fear of unknowns cause us to defer or alter the deployment of capital. Indeed, we have usually made our best purchases when apprehensions about some macro event were at a peak. Fear is the foe of the faddist, but the friend of the fundamentalist.
“A different set of major shocks is sure to occur in the next 30 years,” Buffett went on. “We will neither try to predict these nor to profit from them. If we can identify businesses similar to those we have purchased in the past, external surprises will have little effect on our long-term results.”
“People get way too wrapped up in what the Fed is doing or the economy or China or currency issues,” says Chris — reiterating Buffett’s message 20 years on. “They let these things distract them from the task of investing soundly. Ironically, it seems to me that the smartest people are the ones most likely to try to predict the unpredictable.
“I say go ahead and read whatever you want. Debate the big ideas of the day. Complain about the Fed with your friends on the golf course. Tell them the world is going to hell at the poker table. Decry the state of the world over cocktails.
“But when you sit down to invest your money — forget all that stuff and focus on the timeless principles of good investing. Look for good businesses that can compound capital at a good rate for a long time, run by honest and talented people (who are also owners), and aim to hold them for years.”
Those are the keys to 100-baggers — the stocks that can turn a $10,000 investment into $1 million. Yes, it sometimes takes courage to hold on. But the rewards are immense — as Chris shows time and again in his new book. (You can still get a free copy, as long as you can cover our shipping and handling costs. Order here.)
“If we owed the state money, they’d come take it and they don’t care whether we have a roof over our head,” observes Oglesby, Illinois, resident Susan Rick.
Rick and her boyfriend, Danny Chasteen, recently won $250,000 in the Illinois lottery. But they haven’t been able to collect.
The state is entering its fourth month without a budget. The Republican governor and Democratic lawmakers can’t come to terms. Contractors aren’t being paid. And lottery winners are having to wait.
At least those lottery winners who are entitled to more than $25,000. Checks that big must be processed by the state comptroller. But until a budget is passed, no checks. Just an IOU. And so it’s gone since the new budget year began July 1. The Illinois Lottery stopped issuing press releases about big-money winners Aug. 17.
When your editor left Illinois eight years ago, it was a fiscal basket case. It’s only gotten worse. Illinois ranks last in fiscal solvency, according to a report from the Mercatus Center we cited here in The 5 two months ago. The budget dispute centers in part on the state’s pension system, which suffers from years of overpromising and underfunding.
Until the dispute is resolved, lottery winners are on hold. But as Rick and Chasteen aptly points out, IOUs don’t cut it when the shoe’s on the proverbial other foot.
“There was a time when USA had the best gas prices in the world and the most stable pricing,” a reader writes. “We lost our advantage when we lost the ability to supply our own needs and began to import.
“Today we don’t really need to import much oil, but we still find ourselves at the mercy of OPEC. Why should we let them decide the price of American oil? There is nothing that prevents us from establishing our own price per barrel, except for the small portion we import.
“Place a tariff on imported oil. Set a price for domestic production that enables us to continue our expansion and forget what OPEC does. It is ridiculous for us to be in a price war with them when we don’t export our oil. At $75.00 a barrel, we can still have $2.50 gas and reasonable diesel, and no one goes bankrupt.
“Until OPEC tires of its games and raises the price higher than our fixed one, we need have no concern. We don’t hurt them, and they don’t destroy our oil industry.”
The 5: You want the government to “set a price for domestic production”?
And you do realize net imports still account for 27% of U.S. oil consumption, right?
If anything, the government should get out of the way and allow U.S. crude exports. The standard objection is that U.S. refiners would have less oil to refine. “Not necessarily,” Byron King wrote his readers earlier this year, ‘because U.S. refineries are geared to refine heavy grades of crude, such as the U.S. imported for much of the past 45 years.
“The problem for many refiners is that much new U.S. oil from fracking is too light to run in most U.S. refineries. Thus, U.S. refineries still import foreign oil, such as heavy crude from Venezuela or Canadian oil from oil sands. Then it all gets blended into the light oil from fracking.
“Right now, there’s a glut of light crude oil on U.S. markets due to fracking. It’s a logistical mess to refine it all in U.S. refineries. Yet there’s a strong foreign market for light U.S. crude oil, if only the U.S. government would allow that.
“U.S. refiners would still have plenty of crude to refine. The glut of light oil would move overseas into friendly markets. Lower world oil prices would reset refined product prices lower. You’d likely notice it at the pump.”
“Jim Rickards says a big part of the financial problems today are the result of not enough government regulation of the financial system,” writes a reader — referring back to Tuesday’s episode of The 5.
“What is needed,” Jim wrote, “is not more money but smart infrastructure investment, lower taxes and smart regulation (which means more regulation for banks and less for businesses and entrepreneurs)…” [Emphasis added by our reader.]
Our reader says, “It sounds like he would support the Feds creating brain trusts to guide them to ‘smart’ regulations and ‘smart’ ‘infrastructure investments.’ The underlying assumption: Government regulations and ‘investments’ are needed, and they must be ‘smart.’ Oy…”
The 5: Yeah, we hear ya.
Jim’s point is that as long as the banks have a taxpayer backstop, they’ve gotta be regulated. Even hard-core Austrian School economists we’ve interviewed like Frank Shostak agree on that point. And Ron Paul voted against repealing the Glass-Steagall Act in 1999 — an act of “deregulation” Bill Clinton signed into law, helping set the stage for the Panic of 2008.
Best regards,
Dave Gonigam
The 5 Min. Forecast
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